What's The Next Bubble?

By Geoffrey Michael | August 14, 2011 AAA

While the housing bubble has imploded, there may be other bubbles that haven't yet been hit by the economic downturn of the past few years. While these bubbles have held up fairly well so far, what happens if poor economic conditions continue or get even worse?

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The U.S. economy is currently being propped up by annual deficits of about $1.1 trillion, almost 10% of reported GDP. That represents a substantial portion of total government spending, and is being used to cover expenses ranging from national defense to Social Security. What would happen if lending to the U.S. government stopped because the U.S. was no longer viewed as a viable credit risk? What would happen if the Federal Reserve could no longer print money (quantitative easing) because of rampant inflation or a crashing dollar?

There is a variety of scenarios that could cause other bubbles to burst, some in a very big way. Here are a few that may be sitting ducks. (Bubbles are deceptive and unpredictable, but by studying their history we can prepare to our best ability. See 5 Steps Of A Bubble.)

Commercial Real Estate (CRE)
CRE will face multiple challenges this year including new rules adopted under the Wall Street Reform and Protection Act. A new accounting standard for leases is also under consideration that would affect the refinancing process. These issues, along with higher interest rates, could exacerbate existing market conditions and high valuations in many markets.

Since CRE relies heavily on consumer demand, the demand for CRE is directly impacted by unemployment and prevailing wages. Service sector industries and businesses are particularly sensitive to changes in disposable income. Consumer Reports publishes a monthly index that measures overall sentiment as a function of five factors: Retail Index, Employment Index, Trouble Tracker Index, Stress Index and Sentiment Index. The August reading was down 5.1 to a 20-month low of 43.4. That's the biggest drop for one month in the last two years.

Putting additional pressure on CRE is that a sizable amount of loans will come due over the next three years, including billions in shopping center loans that were financed at historically low interest rates. Declining values make financing hard to come by as lenders have sought reliable metrics that limit their underwriting risk. The deep and prolonged recession has made it more difficult for properties to meet loan-to-value targets as values have dropped. While financing may be more difficult, liquidity has improved as a result of the reemergence of collateral mortgage backed securities.

Unless the job picture improves substantially, continued weakness in consumer demand could place CRE in peril, especially those properties that are now only marginally profitable or barely squeaking by. As with all real estate, the physical location of the property is a major factor in predicting relative price stability.

Athlete Incomes
The sports world is no stranger to exorbitant salaries. Forbes evaluated the top 50 earners based on total income before taxes for the year ending May 1, 2011. The average income for this group was $28 million, including base salary, bonus, endorsement and licensing fees, prize money, and personal appearance fees.

Sports teams and commercial sponsors believe it's worth paying huge salaries to stars like Tiger Woods and Kobe Bryant because of the value they bring to their respective sports. Wherever they go, the fans turn out to see them play and buy the merchandise they endorse. But what would happen if attendance dropped off and product sales declined because of a worsening economy?

The survival of sports as a business is largely dependent on the sufficient discretionary income of its fans. This applies to those in the entertainment and music business as well, so movie stars and concert performers could also take a hit if that income deteriorates.

College Salaries, Tuitions and Student Loans
These bubbles are interrelated because they all feed off each other and form a vicious circle. Higher salaries for professors mean colleges have to charge more for tuition, resulting in bigger loans for the students. About two-thirds of all college graduates have unpaid debt, and the amount of average debt has more than doubled in the past decade. There is no sign yet that this never-ending cycle is about to collapse, but like all bubbles, the bigger it gets the more likely it is to burst.

One of the major reasons for the expanding bubble is that tuition has been increasing about 8% per year, triple the rate of inflation. At that rate, a college education doubles every nine years. Today, the average graduate leaves college with over $23,000 in debt. That's a staggering statistic in an economic environment where jobs are hard to find and extremely competitive.

One of the factors driving those skyrocketing tuitions is the generous pay being offered to college presidents and professors. In 2008, 23 private college presidents took home at least $1 million annually, with another 110 exceeding $500,000. Someone has to pay that bill, and it's being passed through to the students. According to the New York Times, colleges have doubled their non-teaching staffs over the past 20 years, while student enrollment grew only 40%. More than ever, the very existence of many colleges depends on federal loan funds, and they would be in serious trouble if those funds ever dried up.

The Bottom Line
While these three bubbles have the potential to pop soon, there are others that could be vulnerable depending on how the economy looks over the next few years: commodities, precious metals, U.S. treasuries and health care technology are among them.

While some claim gold is in a bubble, others point to the fact that it's still well below its inflation-adjusted high reached in the 1980s. In addition, the rise in gold is a clear signal that many investors lack confidence in paper currencies such as the dollar and euro. While U.S. treasuries have been attractive investments as a perceived safe haven, a real economic recovery would likely draw money away from treasuries and into equities and other investments.

The exponential rise in health care costs isn't sustainable because there won't be enough money to pay for it. There will be a breaking point unless changes are made to government-funded programs like Medicare and Medicaid. We've also discovered that as the government tries to deal with one bubble, it often creates a new one somewhere else. (Find out what the Japanese and U.S. bubbles can tell us about recovering from financial chaos. Refer to Lessons Learned: Comparing The Japanese And U.S. Bubbles.)

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